UBS Scores Interim Win in Push Against Swiss Capital Demands

(Bloomberg) — UBS Group AG notched up an interim victory in its multi-year struggle against Switzerland’s push to make it hold billions of extra dollars in capital.

The Zurich-based bank should be able to use convertible debt, known as AT1s, for as much as 50% of the extra requirement, provided that those instruments are reformed, lawmakers from the key Economic Affairs and Taxation Committee of the upper house said on Monday.

Since the collapse of Credit Suisse more than three years ago, the Swiss government has been seeking ways to make its lone remaining global bank crisis-proof. A key plank of its reform agenda is a capital requirement hike of around $20 billion, intended to make sure that UBS’s foreign businesses can’t sink its domestic entity.

UBS executives have argued that the measure will make it uncompetitive. The bank has tacitly backed the AT1 measures as a potential compromise.

The “committee has backed a materially softer approach,” said Joseph Dickerson and Theo Massing, analysts at Jefferies, in a note. “The result would enable UBS to have more flexibility around how it meets the Swiss government’s demand to back foreign subsidiaries.”

The bank didn’t immediately comment on the committee decision. The Swiss Bankers Association, a lobby group, said in a statement that it welcomed the reform proposals for AT1 instruments but rejected the stricter capital requirements.

Speaking near Basel on Tuesday, Finance Minister Karin Keller-Sutter blasted the committee’s proposal.

“This is a solution in favor of the bank and against taxpayers,” she said, adding that it fails to achieve the goal of making UBS safer.

Keller-Sutter highlighted that she’s confident the final outcome will be different at the end of the legislative process. There was a “significant minority” in the committee which preferred a backing with 90% highest-quality equity capital, instead of 50%, she said.

The minister also stressed that earlier concessions the government made to UBS could be reconsidered in case of a watered-down solution on capital requirements. In an easing of previous proposals, the government had said in April that it will continue to let UBS count deferred tax assets toward its regulatory capital and to write down software from that metric over a period of three years.

The committee’s endorsement, if it makes it through a legislative process due to run until at least next year, would soften the impact of the extra capital requirement on the basis that debt funding is generally cheaper than pure equity.

The committee voted 10-2 in favor of the 50% recommendation, with one abstention.

While the upper house committee’s stance will influence the debate ahead, it’s only one step in a lengthy legislative process. Lawmakers in the more left-leaning lower house could reverse some of the concessions to UBS.

The Social Democrats, the second-largest party in parliament, issued a statement on Monday criticizing the committee’s stance. That signals a potentially harder fight as the political process continues.

The next stop is a vote on the upper house’s floor that’s set to take place during the chamber’s autumn session from Sept. 14 to Oct. 2.

AT1s were born in the aftermath of the global financial crisis as a way to increase a bank’s loss-absorbing capacity. UBS is a substantial player in AT1s globally, and the debt that it has issued accounts for about 7% of the $286 billion European market.

Debt investors generally expect lower returns on their capital than equity investors. Using less equity also helps the bank’s profitability metrics and can affect bonuses.

‘No UBS Win’

UBS should back all of the value of its foreign units, using the combination of equity and AT1 debt, the committee said. That meets the government’s initial demand — though the Finance Ministry has criticized the use of AT1s as not reliable as a means of absorbing losses in a crisis.

The lawmakers backed changes to the instruments that would enable them to kick in earlier in stress situations, addressing a key weakness of AT1 debt that emerged during Credit Suisse’s decline.

There, the bonds didn’t serve any loss-absorbing function until after the bank had to be rescued by UBS, has cast doubt on their role generally. Some $17 billion of AT1 debt was written off as part of the package, resulting in multiple legal challenges.

Under the proposal that lawmakers backed, UBS would face several obligations in case it falls below its minimum requirement for highest-quality equity capital, CET1. According to a draft distributed to journalists, the bank would be barred from paying dividends or making any share buybacks as well as from paying coupons on its AT1 bonds. At the same time, the bonus pool would be reduced.

Erich Ettlin, the president of the committee, said on Monday that the solution would “serve Switzerland,” and “is no victory for UBS.”

Analysts at RBC said that the government’s response to the AT1 softening was now key, given that the finance ministry had indicated it could tighten some aspects of the legislation itself if parliament were “too soft.”

“It had also explicitly not reviewed changes to AT1 instruments, awaiting more clarity at the international level,” analysts including Anke Reingen wrote in a note. “It is somewhat surprising that AT1 instruments might play a large role given the still outstanding case of AT1 write down in connection with the CS takeover.”

–With assistance from Isabel Demetz, Noele Illien and Macarena Muñoz.

(Updates with finance minister starting in seventh paragraph)

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